Generic drugs (small molecule)

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Generic drugs are drugs manufactured and marketed without a brand name. In practice, generics are often marketed as equivalents to branded drugs. Generic drugs are generally much cheaper than their branded counterparts for a number of reasons. First, drug development is extremely time consuming and costly. On average, brand-name drug companies spend about $800 million to discover, develop, and produce a new drug. They then have to charge fairly high prices to recoup their investment and actually make a profit. Generic manufacturers, however, don't have to spend nearly as much on drug development. To gain FDA approval, all a company has to do is prove that its version of a drug is chemically equivalent to the original. If the chemical makeup is the same, it's assumed that the research and clinical trials are as applicable to the generic version as they were to the original. Also, generics manufacturers benefit from advertising for branded drugs, lowering their own marketing expenses.

In the U.S., pharmaceutical patents last for 17 years, during which time only the original developer can legally produce the drug covered by the patent. After the expiration of the patent, other drug companies can produce and sell generic versions of the drug. This often leads to price competition, which decreases profits for the manufacturers of branded drugs. Even before patent expiration, generic drug companies can challenge the patent's validity or argue that their version doesn't infringe on the existing drug's patent. The first company to apply for FDA approval for a generic, in spite of an existing patent, receives a 180-day period of exclusivity to produce and sell the generic version. Though a legal battle usually ensues, resulting in significant litigation expenses, the profits from selling the generic version are generally far more than enough to cover any legal costs.

Generic drugs are often brought up in debates about the U.S. health care system as a whole. Many claim that pharmaceutical companies overcharge for their prescription drugs, making quality healthcare too expensive for some to afford. Drug companies cite the high costs of drug development as the reason for high end-user prices. They also often decry the length of patent protection, saying that they have to recoup all the money spent on development within a relatively limited period of time, forcing them to charge higher prices. Nonetheless, there is growing political pressure to lower prescription drug prices and relax the restrictions on generic drug production, despite pharmaceutical companies' warnings that this could slow or hinder the development of life-saving drugs.

Who benefits from generic drugs?

Generic drug companies

Teva Pharmaceutical Industries (TEVA), an Israel-based pharmaceutical company, is the world's largest producer of generic drugs. Sanofi-Aventis recently filed a lawsuit against Teva for infringing on its patent for the blockbuster cancer treatment Eloxatin.

Sandoz, a subsidiary of Novartis AG (NVS), is also a leading producer of generic drugs, contributing $6 billion to Novartis' 2006 revenues of $37 billion. It is also being sued by Sanofi-Aventis over Eloxatin's patent.

Walgreen Company (WAG), CVS (CVS), Rite Aid (RAD), and Longs Drug Stores (LDG) are four of the largest pharmacy chains in the U.S. Generic drugs are much cheaper than their branded counterparts, so pharmacies are able to purchase their drugs at lower wholesale prices. While some of the cost savings is passed on to customers, the pharmacies are able to still make much higher profit margins on generic drugs. As the chart below demonstrates, the price difference between branded and generic drugs is often not as large as would be expected, considering the much lower costs involved with producing and developing generic drugs.

Who's hurt by generic drugs?

The companies most negatively impacted by generic drugs are the pharmaceutical companies who originally develop new drugs. When their patents expire, these companies are usually forced to lower their prices in order to compete with the cheaper generic versions of their products. Major pharmaceutical companies generally charge relatively high prices for their drugs while the patents are in effect, which allows them to recoup their R&D costs and make a profit before generics become available. Nonetheless, generics eventually lead to either lower profit margins or a loss of market share, both of which are less than ideal for drug companies.

Some major pharmaceutical companies and approaching patent expirations include: